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Salman Ahmed Shaikh

Shari’ah compliance in Islamic banking is necessary. However, achieving that requires certain additional operations and costs which may lead to Islamic banks incurring some additional costs which conventional banks simply avoid. This may make Islamic banks to become costlier than conventional banks and which will reflect in weak position in price competitiveness.

Around the world, a large number of people and even experts still have apprehensions about Islamic banking. It is because in their view, they are not even price competitive, let alone more inclusive and egalitarian than their conventional counterparts. With use of Tawarruq, Bai Inah, Sale and Leaseback structures, economists and finance experts find it difficult to appreciate or concede distinctive merit to Islamic banking from finance and economics perspective.

In search for ensuring price competitiveness given the internal and external disadvantageous factors, Islamic banks find it hard to innovate in product design from the point of view of serving the economic and financial needs in a different cash flow pattern.

First, it results in relatively disappointing performance in ensuring financial inclusion of involuntary financially excluded segments of the society, especially on the financing side.

Second, it also results in higher spread where a faith premium is to be paid by financing side clients (high cost of finance), investment depositors (lower return on deposits), shareholders (lower return on capital) or government (by providing subsidies to one of the first two stakeholders).

Third, it also results in losing distinctive mark in distributional impact. If conventional banking is providing finance and credit to a minority of capitalist elites, Islamic banks provide financing to the same segment even more narrowly with relatively higher cost of intermediation.

Have Islamic banks been able to widen their outreach beyond large cities or not so that involuntary financial exclusion due to outreach constraints is also minimized. As of now, they are relatively more urban-centric than conventional banks at the moment.

Like conventional banking, Islamic banks are also majorly financing the corporate sector. Majority of the total financing in Islamic banking goes to the corporate sector. SMEs and agriculture get a small share. There is still no Islamic microfinance bank in Pakistan.

Even though institutions like Akhuwat had provided Qard-e-Hasan based loans to 5 million people with a recovery rate of around 99%, but Islamic banks or their sponsors had not ventured in providing micro financial services as enthusiastically as they ventured in Islamic commercial banking and asset management.

The deposit mobilization picture in Islamic banking in Pakistan suggests that their reliance is majorly on non-remunerative current accounts. Hence, they could have provided subsidised financing to critical sectors of the economy like agriculture and SMEs sector.

Even on saving accounts, Islamic banks pay much less returns to the depositors than conventional banks in some jurisdictions like Pakistan, for instance. Not only they have much less cost of deposits than conventional, but they also fall short of expectations when it comes to outreach to economic sectors like agriculture and SMEs and even when it comes to pricing.

Even where Islamic banking does provide financing solutions to the corporate sector and upper income class urban population, it does so at an equal or higher cost of finance than conventional. Intermediation function performed by Islamic banks is costlier, yet inferior from the distributional perspective since they have much less exposure to agriculture sector, SME sector and almost nothing when it comes to microfinance sector. From the economics perspective, depositors in Islamic banking obtain much less profits as compared to depositors in conventional banks.  Therefore, on the grounds of competitiveness, Islamic banks have still a long way to travel.


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